No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.
Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.
Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.
But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.
Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.
“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.
Notwithstanding its big bounce during the financial maelstrom last year, the dollar has been on downward trajectory for most of this decade. The U.S. dollar index, which currently stands around 78, once traded well above 100. In the early days of the dollar’s decline, currency traders worried about general diversification where central banks with big dollar reserves would begin to shave off a small portion of their holdings and exchange them for something else like euros.
The financial crisis, however, woke the world up to just how vulnerable those squirreling away dollars — like China and Russia — were to the fortunes of the United States. The bulk of the world’s currency reserves are in dollars, with the euro still a distant second. Foreign central banks, however, could hardly start selling dollar-denominated assets to limit their exposure because such sales would cause prices on their remaining holdings to fall further.
So far, calls for alternative currencies have been seen as political posturing for both international and domestic audiences alike, but the United States. has a lot to lose if it ever turns into something more concrete.
That’s because the loss of reserve status means, among other things, that the United States would lose a crucial crutch that has allowed it to borrow its way into prosperity as well as out of depression with relative impunity. Foreign investment in dollar assets have helped keep a cap on interest rates even though the government’s borrowing binge in recent years has brought new meaning to the word stimulus.
In an op-ed published in the New York Times today, Warren Buffett railed against the flowing red ink that will push the nation’s debt to roughly 56 percent of GDP from 41 percent in this fiscal year.
Presumably this is something that has also caught the eye of foreign investors.
While the greenback is likely to stay on top for some years, persistent concerns about its reserve status and moves to diversify away from it could usher in a new era for U.S. borrowers, public and private alike — a more painful one where debt costs can no longer be offset by the kindness of foreign investment.